Collateral Key When Businesses Go Bankrupt

According to the United States Courts, over 60,000 businesses filed for bankruptcy in 2010. These businesses undoubtedly owe billions of dollars to their creditors. So, how can creditors collect their money from businesses that have none?

First, here's a quick lesson on business bankruptcy. There are two available types of bankruptcy; Chapter 7 and Chapter 11. Individuals, married couples, corporations, and partnerships can all file for Chapter 7 bankruptcy, and, in most cases, most/all debts of individuals are discharged and the entity goes out of business. Chapter 11 bankruptcy is a reorganization proceeding used mostly by corporations or partnerships. In Chapter 11, the business can continue with business operations after reorganizing outstanding debts, giving them the opportunity to rehabilitate their business or to liquidate in an orderly fashion to maximize creditor payback..

Lenders typically look for repayment through three avenues: cash flow, collateral value, and personal/business guarantees. If a business fails and is unable to pay off debts through cash, the lender usually resorts to a second source of repayment - collateral.

Lenders use the appraised value of collateral as a starting point to determine what they can and will repossess. Collateral can include any type of equipment, inventory, other accounts, or real estate. The lender is looking to liquidate these assets as soon as possible so that it can quickly collect debt repayment. Before even granting a business loan, the lender looks at the type of collateral being pledged to determine the feasibility of collecting payment through selling off a failed business's assets. For example, a lender could resell a standard delivery van more quickly than it could a neon sign with the business's logo.

Real estate is an important type of collateral, as it has a higher appraised value than equipment (in most cases) and can therefore be sold more easily. Lenders prefer improved land to raw land, as long as the improved land hasn't been developed for a solitary purpose (i.e. car wash lot).

Through collecting collateral, a lender can often regain the money it loses when a business declares bankruptcy. The negotiation process here is key, as lenders must work with businesses to find the best solution for repayment.

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